The Pound Faces a Friendless Summer

A strong dollar and Brexit bode ill for the currency, and the central bank is largely powerless.

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Photograph: EyesWideOpen/Getty Images Europe

The Bank of England will almost certainly keep rates on hold at Thursday’s Monetary Policy Committee meeting, and that means the pound is vulnerable to a further sell-off. There’s not much the BOE can do about it.

Thursday’s MPC decision and press conference from Governor Mark Carney will be a sad exercise in the unreliable boyfriend twisting himself into knots to talk interest rate expectations up — and the pound with it — when really he can’t.

Not Much Support

Sterling's drop below its 200-day moving average doesn't bode well for a rebound

Source: Bloomberg

The currency has fallen nearly 6 percent versus the dollar since mid-April, most recently breaking through its rolling 200-day moving average. Most of that weakness can be put down to renewed strength in the dollar. But as sterling has also fallen nearly 2 percent versus the euro in the same period, it is not the only factor.

Brexit negotiations must take a share of the blame. Conflicts within Prime Minister Theresa May’s cabinet seem to be an obstacle to the kind of divorce that would encourage business investment and potentially stoke growth. The economy has stumbled on poor weather, and looks like it’s struggling to regain its footing.

Jaw Jaw

U.K. rate expectations have unwound most of the BOE's hard work on talking up rate hikes

Source: Bloomberg

But then there is the role of Carney himself. Conflicting messages on how soon, and by how much, rates will rise have roiled the sterling money markets. Investor expectations that the bank will hike in May have evaporated from near certainty to just a 12 percent probability now, and August isn’t looking great either.

Fading Chances

Investor expectations for a rate hike to 0.75% in August are pretty much a coin toss

Source: Bloomberg WIRP function

Weighted implied probability using overnight interest-rate swaps

There’s also slim prospects that the BOE will be able to embark on a rate-normalizing path anytime soon, and that has yanked a stool from underneath sterling. Sadly, matters now are largely out of the BOE’s hands. It can’t control the dollar, with the Federal Reserve committed to at least three rate hikes this year — though it could be more than that, if JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon is right. Likewise, the outcome of Brexit negotiations is simply a card it gets dealt.

The one thing it can do is set hawkish expectations on Thursday, but with first-quarter growth so weak that would be extremely challenging. Thursday also sees the release of the quarterly Inflation Report. If anything, both growth and inflation estimates will be revised lower, so it’s hard to see how these could possibly turn out at levels that would encourage a renewed faith in the currency. 

Carney’s recent flip-flops may count against him just when he needs investors to take his commitment to higher rates on trust. That leaves precious little to put a floor under the pound.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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